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1.040 Project Management Spring 2009

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Project Organization IIProject Organization II

Spring 2009Spring 2009Based on Lectures Given by Dr. Nathaniel Based on Lectures Given by Dr. Nathaniel

Osgood in 2005Osgood in 2005

Fred MoavenzadehCivil and Environmental EngineeringMassachusetts Institute of Technology

Project OrganizationProject OrganizationI.I. Project Delivery Systems (most common)Project Delivery Systems (most common)

Design / BuildDesign / BuildOthersOthersSummarySummary

II.II. Payment SchemesPayment SchemesGeneral pointsGeneral pointsLumpsumLumpsumCost plus fixed fee/% priceCost plus fixed fee/% priceUnit priceUnit priceGuaranteed maximum priceGuaranteed maximum price

III.III. Award MethodsAward MethodsGeneral pointsGeneral pointsNegotiationNegotiationBiddingBidding

Part IPart I

Project DeliveryProject Delivery

DesignDesign--BuildBuildOwner

Sub contractor

Sub contractor

Sub contractor

Contractual RelationshipCommunicational RelationshipInternal Relationship

Construction Function

Design Function

D/B Entity

How To: Design / BuildHow To: Design / BuildOwner Owner

Develops early design (to communicate needs)Develops early design (to communicate needs)Hires a design/build firm that will complete both Hires a design/build firm that will complete both design and constructiondesign and construction

This firm can be a design/build firm but also This firm can be a design/build firm but also a jointa joint--venture firm for this specific projectventure firm for this specific projectDB company may hire subcontractorsDB company may hire subcontractorsWork solicited via RFP (honorarium, phased)Work solicited via RFP (honorarium, phased)Can be good for complex projects Can be good for complex projects –– but need but need phased design to shield parties from riskphased design to shield parties from risk

Back to the FutureBack to the Future……

Dominant method early in US historyDominant method early in US historyRecent driversRecent drivers

Time pressure (desire to fast track)Time pressure (desire to fast track)Shortcomings of tightly defined architect roleShortcomings of tightly defined architect role

Constructability issuesConstructability issuesLimited A/E oversight of constructionLimited A/E oversight of construction

Downsizing of US corporations (outsourcing design)Downsizing of US corporations (outsourcing design)Desire for single source of responsibilityDesire for single source of responsibility

Advantages DBAdvantages DB

Allows Fast Tracking Allows Fast Tracking May be good for some complex projectsMay be good for some complex projects

Close coordination within teamClose coordination within teamInstitutional knowledge build up Institutional knowledge build up

Single source of accountabilitySingle source of accountabilityOwner need not mediate or be exposed to Owner need not mediate or be exposed to designer/contractor conflictsdesigner/contractor conflictsEasier incorporation of changes caused by Easier incorporation of changes caused by field conditionsfield conditions

Disadvantages DBDisadvantages DBLack of fiduciary relationship with designerLack of fiduciary relationship with designer

Risk of DB sacrificing Risk of DB sacrificing designdesign quality to protect profitquality to protect profitOwner must assume responsibility for quality assuranceOwner must assume responsibility for quality assurance

Pricing not possible at the beginningPricing not possible at the beginningDemands sophisticated owner (construction, Demands sophisticated owner (construction, quality, oversight of submittals, negotiation,quality, oversight of submittals, negotiation,……))

Must stay on top of design so donMust stay on top of design so don’’t get surpriset get surpriseCan be bad for many complicated projectsCan be bad for many complicated projects

Very important for owner to be closely involved to Very important for owner to be closely involved to specify important and complex aspects of designspecify important and complex aspects of design

Package: CanPackage: Can’’t pick or get rid of individual team t pick or get rid of individual team members (e.g. individual subcontractors)members (e.g. individual subcontractors)

DesignDesign--Build Disadvantages IIBuild Disadvantages II

Need to make sure design goals stay foremostNeed to make sure design goals stay foremostOften contractorOften contractor’’s interests within DB dominates interests within DB dominate

Fewer checks and balances Fewer checks and balances Problems may be hidden until late (no A/E watch)Problems may be hidden until late (no A/E watch)May take direction that owner does not really wantMay take direction that owner does not really wantDesignDesign--build firm can give high quote for changesbuild firm can give high quote for changes

Responsible for everything!Responsible for everything!If fast trackedIf fast tracked, c, changes can lead tohanges can lead to

ReworkReworkIterationIterationDelaysDelays

Public Use ChallengesPublic Use Challenges

Regulatory hurdlesRegulatory hurdlesFederal use allowed Federal use allowed

Federal Acquisition Reform Act of 1996 allowedFederal Acquisition Reform Act of 1996 allowedMany states still do not allow Many states still do not allow

Special permission may be granted for formal requestSpecial permission may be granted for formal requestMajor opposition fromMajor opposition from

Architectural lobbyArchitectural lobbyUnionsUnions

Bridge Designer/EngineerBridge Designer/Engineer

Serves as bridge betweenServes as bridge betweenOwnerOwnerDesignDesign--build teambuild team

Performs preliminary design before DB team hiredPerforms preliminary design before DB team hiredE.g. up to 30% designE.g. up to 30% design

Monitors development of design and constructionMonitors development of design and constructionFiduciary with ownerFiduciary with owner

DB Selection ConsiderationsDB Selection ConsiderationsTiming tension for when to recruit DB firmTiming tension for when to recruit DB firm

Earlier recruitment:Earlier recruitment:Hard to judge Hard to judge –– like beauty contestlike beauty contest

Later recruit: Less benefit from DBLater recruit: Less benefit from DBE.g. Lower ability to fastE.g. Lower ability to fast--tracktrackLimit creativity (closer to GC)Limit creativity (closer to GC)

Often have segmented pricing (costOften have segmented pricing (cost--plus design, fixed plus design, fixed price or GMP construction)price or GMP construction)More comprehensive selection process typicalMore comprehensive selection process typical

Design/Price/Schedule/TeamDesign/Price/Schedule/TeamDesign competitions undertakenDesign competitions undertaken

Example DesignExample Design--Build: I15Build: I15Originally slated as DBB, but made DB to fastOriginally slated as DBB, but made DB to fast--tracktrack

Hard deadline due to 2002 SLC Olympic GamesHard deadline due to 2002 SLC Olympic Games$1.3B joint venture (Kiewit lead company)$1.3B joint venture (Kiewit lead company)US DOT as owner agencyUS DOT as owner agencyBiddedBidded project (with rights to use unsuccessful)project (with rights to use unsuccessful)

Unsuccessful bidders became subcontractorsUnsuccessful bidders became subcontractorsReputation foremostReputation foremost

200 Subcontractors200 SubcontractorsFew reviewsFew reviews

Finished 5 months ahead of scheduleFinished 5 months ahead of schedule

Modified CM Design/Build:Modified CM Design/Build:Design SubcontractedDesign Subcontracted

(CM Serves as Design/Builder and Subcontractors Design)(CM Serves as Design/Builder and Subcontractors Design)

[Howell et al., 1998]

Owner

CMDesign/Builder

Sub-Contractor Sub-Contractor Sub-Contractor Sub-Contractor

Architect/Engineer

CM Oversight Design/BuildCM Oversight Design/Build(CM Provides Agency Oversight on Owner(CM Provides Agency Oversight on Owner’’s Behalf)s Behalf)

[Howell et al., 1998]

Owner

Design/Build Contractor

Sub-Contractor Sub-Contractor Sub-Contractor Sub-Contractor

CM

Other Delivery MethodsOther Delivery Methods

Turnkey (Like DB but Contractor Financed)Turnkey (Like DB but Contractor Financed)Very common in residential housingVery common in residential housingGives owner time to raise money during construct.Gives owner time to raise money during construct.

DesignDesign--BuildBuild--OperateOperate--Transfer (BOT)Transfer (BOT)LongLong--term financing (vs. DBO)term financing (vs. DBO)Can compete on size, transfer time, etc.Can compete on size, transfer time, etc.Have different guarantees needed to enticeHave different guarantees needed to entice

Multiple PrimesMultiple PrimesPhase Phase construct.,handconstruct.,hand--pick pick team,sophisticatedteam,sophisticated ownerowner

Owner/Agent (owner does part of design)Owner/Agent (owner does part of design)

Type of Relationships Among Type of Relationships Among ParticipantsParticipants

Owner- Owner- Owner-A/E

A/E-A/EContr. CMCM- CM-

Contr. Contr.DBBPCM

CMRD/B

K

K

K

K

C

CC C

KI

KK

K

K*

_ _

_

_ _ _

___

*: Contractual Relationship between the Owner and the D/B Team

K: Contractual RelationshipC: Communication RelationshipI: Internal Relationship

Image by MIT OpenCourseWare.

Advantages of the 3 Most Advantages of the 3 Most Common Delivery MethodsCommon Delivery Methods

Type of contracts Trad

itio

nal

App

roac

h

Des

ign

Build

Cons

truc

tion

M

anag

emen

t

AdvantagesLegal and contractual precedent XCost determined before contract commitment XFast-tracked construction allowed X XMinimum owner involvement X XCost benefit from competition X XNegotiation with quality contractor for unique expertise X XAllow adjustment to new conditions without changing agreement X XSingle firm control of design/construct process X

Adapted from Gould and Joyce, 2002

Disadvantages of the 3 Most Disadvantages of the 3 Most Common Delivery MethodsCommon Delivery Methods

Type of contracts Trad

itio

nal

App

roac

h

Des

ign

Build

Cons

truc

tion

M

anag

emen

t

DisadvantagesDesign does not benefit from construction expertise XDesign construction time is the longest XAdversarial relationship owner/designer vs contractor XContract agreement affected by changes XFew checks and balances XCost control occurs late in project XContract amount may be complicated by continual contractor negotiations XContract agreement affected by unforeseen conditions X

Modified from Gould and Joyce, 2002

~x~x

~x~x

Issues with BidsIssues with BidsLow bidders can be unreliableLow bidders can be unreliable

Prequalify aggressively!Prequalify aggressively!

To allow for fastTo allow for fast--tracking may bid early (30%)tracking may bid early (30%)DonDon’’t try to force delivery from low bidt try to force delivery from low bidGrowing Frequency: innovative bidding methodGrowing Frequency: innovative bidding methodPressure for lowest bid can createPressure for lowest bid can create

Cutting cornersCutting cornersLowLow--quality personnelquality personnelBad feelingsBad feelings

Part IIPart II

Payment SchedulePayment Schedule

Payment SchemesPayment Schemes

ExtremesExtremes

Fixed Price

CommodityService

Reimbursable

Solicit based on Reputation and agree via Negotiation

Bidding

Product Type:

Payment method:

Award method

Key Idea Here: Risk SharingKey Idea Here: Risk Sharing

Different parties have ability to manage or Different parties have ability to manage or tolerate different types of risktolerate different types of risk

Owner (or big contractor) often better: Geotechnical Owner (or big contractor) often better: Geotechnical risk, weather riskrisk, weather riskContractor better: Risk of slow teams, equipment Contractor better: Risk of slow teams, equipment quality, procurement, quality of supervisionquality, procurement, quality of supervision

Divide risks within an agreement to Divide risks within an agreement to Save money on contract priceSave money on contract priceProvide incentive to contractors to finish early, in Provide incentive to contractors to finish early, in budget, good qualitybudget, good quality

Fundamental IdeasFundamental Ideas

Contractors are often highly risk averseContractors are often highly risk averseRecall risk premiums: Contractor willing to Recall risk premiums: Contractor willing to ““paypay”” owner owner (charge less for contract) if owner takes on risk (charge less for contract) if owner takes on risk –– if have toif have to

For risks that contractor For risks that contractor cancan’’t t control, may be willing to control, may be willing to pay a risk premium to owner to take overpay a risk premium to owner to take over

Contractor here will lower costs if owner assumes certain risk Contractor here will lower costs if owner assumes certain risk (essentially, paying the owner a risk premium)(essentially, paying the owner a risk premium)

For risks that contractors For risks that contractors cancan control, cheaper for a control, cheaper for a contractor to contractor to managemanage risk than to pay a risk premiumrisk than to pay a risk premium

Fundamental Ideas IIFundamental Ideas II

Structure contract so thatStructure contract so thatRisks contractor can better handle are imposed on Risks contractor can better handle are imposed on contractor (i.e. contractor will lose $ if doncontractor (i.e. contractor will lose $ if don’’t control)t control)

To be competitive, will have to To be competitive, will have to managemanage thesethese

Risks owner can better handle are kept by ownerRisks owner can better handle are kept by owner

“’“’Risk can be better handled by A vs. BRisk can be better handled by A vs. B”” here here means that the risk premium that would be means that the risk premium that would be charged by the A for taking on this risk is charged by the A for taking on this risk is smaller than would be charged by Bsmaller than would be charged by B

Fundamental BalanceFundamental BalanceImpose Impose highhigh enough risk incentive to get contractor do enough risk incentive to get contractor do job efficiently job efficiently –– within the specifications of the contractwithin the specifications of the contract

E.g. Incentive to finish on time, incentive to stay within E.g. Incentive to finish on time, incentive to stay within budgetbudgetE.g. better team assignment, equipment provision, mgmtE.g. better team assignment, equipment provision, mgmt

Impose Impose lowlow enough risk to have reasonably low bidenough risk to have reasonably low bidImpose according to contractor ability to tolerateImpose according to contractor ability to tolerate

Derivative Results of Risks I: Derivative Results of Risks I: Accountability/MonitoringAccountability/Monitoring

Consider parties A and B in an agreementConsider parties A and B in an agreementA is contractor; B is ownerA is contractor; B is owner

The greater the risk on party AThe greater the risk on party AThe more incentive on party A to manage this risk The more incentive on party A to manage this risk The less incentive on party B to manage this riskThe less incentive on party B to manage this riskMore incentive on A to monitor the relevant factors More incentive on A to monitor the relevant factors so B canso B can’’t claim the risk is responsible for a problemt claim the risk is responsible for a problemMore incentive on B to make sure that AMore incentive on B to make sure that A’’s means of s means of risk risk managementmanagement falls within the agreementfalls within the agreement

E.g. that not E.g. that not ““cutting cornerscutting corners”” or otherwise cheating to or otherwise cheating to shield from riskshield from risk

Derivative Results of Risks II: Derivative Results of Risks II: Impact on Construction TimingImpact on Construction Timing

Both parties must agree on cost to move forwardBoth parties must agree on cost to move forwardIn general, more risk on one party, less that party is In general, more risk on one party, less that party is willing to move forwardwilling to move forwardMore risk on contractor, the longer will delay construct.More risk on contractor, the longer will delay construct.

Given uncertainty, contractor will charge more up frontGiven uncertainty, contractor will charge more up frontOwner doesnOwner doesn’’t want to pay a huge amount up frontt want to pay a huge amount up frontAs uncertainty is lessened in design, prices converge As uncertainty is lessened in design, prices converge

Owner can expedite Owner can expedite –– by paying higher price (risk by paying higher price (risk premium) to contractor or by shouldering riskpremium) to contractor or by shouldering riskRemember; delay can have major costs Remember; delay can have major costs –– but so can but so can wrangling over change orders!wrangling over change orders!

Note on Change OrdersNote on Change Orders

Changes contract (cost/schedule/scope/etc.)Changes contract (cost/schedule/scope/etc.)Can lead to costs beyond contract specificationCan lead to costs beyond contract specificationAnticipated costs incorporated in Anticipated costs incorporated in ““contingencycontingency””

Often 1Often 1--3% on top of agreed upon price3% on top of agreed upon price

Often only paid for additional direct costsOften only paid for additional direct costsBig problem if disruption in workBig problem if disruption in work

Source of very large riskSource of very large risk

Contractual Risk Contractual Risk AllocationAllocation

100 %RISK Allocation

Lump-Sum (Fixed Price)

0 %

100 %

CO

NTR

AC

TOR

’S R

ISK

0 %

OW

NER

’S R

ISK

RISK SHARING METERModified from Kerzner, 2000

Fixed-Price w/ Economic Price Adjustments

Fixed-Price Incentive

Cost-Plus Incentive

Cost-Plus Award Fee

Cost-Plus Fixed Fee

Cost-Sharing

Cost-Plus Percentage

Cost Versus Price for Lump SumCost Versus Price for Lump Sum

Macomber, 1989

Fina

l Pric

e

$9,5

00

$10,

000

$10,300

$10,

500

Final Cost

(Price is fixed at $10,300)

} {a

b} c

a = If final cost is $9,500, contractor profit is $800 (8.42%)b = If final cost is $10,000, (as expected), contractor profit is $300 (3%)c = If final cost is $10,000, contractor loss is $200 (-1.9%)

Image by MIT OpenCourseWare.

Lump Sum (Lump Sum (““Fixed PriceFixed Price””))Contractor required to achieve the project at Contractor required to achieve the project at the negotiated contract valuethe negotiated contract valueAll risk of cost, schedule fall on contractorAll risk of cost, schedule fall on contractorThe owner knows the actual cost of the The owner knows the actual cost of the project before it beginsproject before it beginsMinimizes risk for the owner if the project is Minimizes risk for the owner if the project is well estimated, contractual documents well estimated, contractual documents accurate and project clearly definedaccurate and project clearly definedHigh incentive for contractor to finish High incentive for contractor to finish

Early (so can move on to other jobs)Early (so can move on to other jobs)Low cost (so can make a profit)Low cost (so can make a profit)

Lump SumLump Sum

Required for many public projectsRequired for many public projectsGood for some wellGood for some well--defined projectsdefined projects

Good price competition in commodity metricGood price competition in commodity metricBad for illBad for ill--defined projectsdefined projects

Adversarial relationship over responsibility and Adversarial relationship over responsibility and payment for of changespayment for of changes

High contractor risk means typically start lateHigh contractor risk means typically start lateVery different from typical meaning of Very different from typical meaning of ““Fixed feeFixed fee””!!

Ways to Save Money: Ways to Save Money: Effect on OwnersEffect on Owners

Helps: Efficiency within constructionHelps: Efficiency within constructionBest teamsBest teamsAppropriate equipmentAppropriate equipmentCareful managementCareful managementQuality workmanship (to avoid risk of rework)Quality workmanship (to avoid risk of rework)

Hurts: Cutting corners, distortion, charge ordersHurts: Cutting corners, distortion, charge ordersSubstitution of materialsSubstitution of materialsDistortion of quantities usedDistortion of quantities usedDistortion of progressDistortion of progress

Cost Versus Price for Cost PlusCost Versus Price for Cost Plus

Macomber, 1989

Fina

l Pric

e

Final Cost

(Price = cost plus 5%)

a = If final cost is $9,500, contractor profit is $475 (5%)b = If final cost is $10,000, contractor profit is $500 (5%)c = If final cost is $10,500, contractor loss is $525 (5%)

$9,5

00

$9,975

$10,500

$11,025

$10,

000

$10,

500

}}

}

a

b

c

Image by MIT OpenCourseWare.

Cost Plus Fixed %Cost Plus Fixed %

Owner is paying the actual cost plus a fixed Owner is paying the actual cost plus a fixed percentagepercentageContractor agrees to do his best efforts to Contractor agrees to do his best efforts to achieve the workachieve the workContractor shoulders very little riskContractor shoulders very little riskTypically select contractors based on reputation Typically select contractors based on reputation and comfort (and comfort (serviceservice rather than commodity)rather than commodity)

Cost Plus + Fixed %: AdvantagesCost Plus + Fixed %: AdvantagesMaximum flexibility to the OwnerMaximum flexibility to the Owner

No fighting over change orders No fighting over change orders –– contractor gets contractor gets paid for any extra work requiredpaid for any extra work required

Permits to collaborate at the early stages of Permits to collaborate at the early stages of the projectthe project

Minimal negotiation timeMinimal negotiation timeMinimal fear of commitment by contractorMinimal fear of commitment by contractor

Only have to pay for what actually costsOnly have to pay for what actually costsIf manage closely, can If manage closely, can save money save money vs. fixedvs. fixed--priceprice

Cost Plus + Fixed %: DisadvantagesCost Plus + Fixed %: Disadvantages

Owner shoulders all riskOwner shoulders all riskLittle incentive to reduce costs and overtime salaries Little incentive to reduce costs and overtime salaries can even increase costscan even increase costsCost unknown until contract completesCost unknown until contract completes

Owner needs to oversee construction closelyOwner needs to oversee construction closelySpeed up slow crewsSpeed up slow crewsIdentify management problemsIdentify management problems

Contractors have incentive to grow scope, priceContractors have incentive to grow scope, priceTerrible with turnkey delivery type!Terrible with turnkey delivery type!

ApplicabilityApplicability

Requires sophisticated owner to manageRequires sophisticated owner to manageUses if the pricing could not be performed in Uses if the pricing could not be performed in any other way and if it is urgentany other way and if it is urgent

Emergencies (civil, military)Emergencies (civil, military)IllIll--defined, risky scope defined, risky scope

e.g. historic building renovation with unknown cond.e.g. historic building renovation with unknown cond.Unknown technologiesUnknown technologies

Either scope or construction method unknownEither scope or construction method unknownConfidential projects (limit public knowledge)Confidential projects (limit public knowledge)

Cost Plus Fixed Fee (Cost Plus Fixed Fee (““Fixed FeeFixed Fee””))

Cost may vary but the fee remains firmCost may vary but the fee remains firmThe fee is independent of the duration of the The fee is independent of the duration of the projectprojectLike Cost + fixed % except some shared riskLike Cost + fixed % except some shared risk

Less time risk: High incentive to finish earlyLess time risk: High incentive to finish earlyLess risk of contractor growing size of projectLess risk of contractor growing size of project

Unit Price ContractUnit Price ContractAgreement on the price charged Agreement on the price charged per unitper unitbetween the contractor and the ownerbetween the contractor and the ownerInteresting example of risk sharingInteresting example of risk sharing

Owner: risk for uncertainty in quantityOwner: risk for uncertainty in quantityContractor: risk for unit price (efficiency, Contractor: risk for unit price (efficiency, procurprocur))

Contractor overhead must be integrated in Contractor overhead must be integrated in the units pricethe units priceNecessity of an owner presence on site to Necessity of an owner presence on site to measure the actual quantitiesmeasure the actual quantitiesTypically renegotiate if quantity 20% offTypically renegotiate if quantity 20% off

Quantity influences price Quantity influences price b/cb/c economies of scaleeconomies of scale

Unit Price ContractUnit Price ContractHighly dependent on the accuracy of the Highly dependent on the accuracy of the estimation of the quantities given by the estimation of the quantities given by the Owner/DesignerOwner/Designer

Risk of unbalanced biddingRisk of unbalanced biddingIf contractor believes actual quantity will differ, case If contractor believes actual quantity will differ, case increase and/or decrease the unit priceincrease and/or decrease the unit priceContractor can make profit because payment is based Contractor can make profit because payment is based on actual quantities but he can also lose money in the on actual quantities but he can also lose money in the same waysame way

A contractor can be excluded if its bid is very A contractor can be excluded if its bid is very unbalancedunbalancedThe total cost for the owner can be greater than The total cost for the owner can be greater than plannedplanned

Example: Pile DrivingExample: Pile DrivingToo risky to just charge fixed priceToo risky to just charge fixed price

Geotechnical uncertainties make length of piles Geotechnical uncertainties make length of piles uncertainuncertainPiles can be highly expensivePiles can be highly expensive

Risk allocationRisk allocationPrice risk more under contractor control (efficiency, Price risk more under contractor control (efficiency, crew and equipment selection): to contractorcrew and equipment selection): to contractorLength out of contractor control: to ownerLength out of contractor control: to owner

Owner must precisely monitor length usedOwner must precisely monitor length used

Cost Versus Price for GMPCost Versus Price for GMP

Macomber, 1989

Fina

l Pric

e

Final Cost

(Price = cost of work plus fixed fee of $500 with a maximum price of $10,500)

a = If final cost is $9,500, contractor profit is $500 (5.26%)b = If final cost is $10,000, contractor profit is $500 (5%)c = If final cost is $10,500, contractor loss is $0 (0%)

$10,500

$10,000

$9,5

00

$10,

000

$10,

500

Guaranted-Maximum-Price Contract

}}

}

a

bc

Image by MIT OpenCourseWare.

Guaranteed Maximum Price or GMPGuaranteed Maximum Price or GMP

Variation of the Cost Plus a Fee but GMP Variation of the Cost Plus a Fee but GMP can be a cap on can be a cap on direct costsdirect costsAfter a certain point, the After a certain point, the ““floorfloor”” or or ““ceilingceiling””, , the contractor assumes any additional coststhe contractor assumes any additional costsOften Often startstart in cost plus fixed fee and then in cost plus fixed fee and then impose GMP at e.g. 90% designimpose GMP at e.g. 90% designBest: GM Shared Savings: Below Guaranteed Best: GM Shared Savings: Below Guaranteed Maximum, savings shared (60Maximum, savings shared (60--40% or sliding)40% or sliding)Very good for turnkey, wellVery good for turnkey, well--defined scopedefined scope

GMP: AdvantagesGMP: Advantages

Permits easier financingPermits easier financingCan fastCan fast--tracktrackOwner keeps savings below GMPOwner keeps savings below GMPOften can get started quickly on constructionOften can get started quickly on construction

Particularly if contractor already involved w/designParticularly if contractor already involved w/design

Contract may be higher than for fixed price Contract may be higher than for fixed price b/cb/cdesign often not complete when contract setdesign often not complete when contract set

GMP: DisadvantagesGMP: Disadvantages

Contractors may still spend lotsContractors may still spend lotsOwner must monitor contractor spendingOwner must monitor contractor spendingCan be fights over what is direct vs. indirect costCan be fights over what is direct vs. indirect cost

i.e. what must fall below GMPi.e. what must fall below GMPBad if unclear scope after GMP agreed to (must Bad if unclear scope after GMP agreed to (must renegotiate)renegotiate)Just as for CPFF, quality may be sacrificed Just as for CPFF, quality may be sacrificed whereas without GMP, cost and/or schedule whereas without GMP, cost and/or schedule would have increasedwould have increased

Relative Costs of Construction ContractsRelative Costs of Construction ContractsE= contractor's original estimate of the direct job cost at the E= contractor's original estimate of the direct job cost at the time of contract time of contract award award M = amount of markup by the contractor in the contract M = amount of markup by the contractor in the contract B = estimated construction price at the time of signing contractB = estimated construction price at the time of signing contractA = contractor's actual cost for the original scope of work in tA = contractor's actual cost for the original scope of work in the contract he contract U = underestimate of the cost of work in the original estimate (U = underestimate of the cost of work in the original estimate (with negative with negative value of U denoting an overestimate) value of U denoting an overestimate) C = additional cost of work due to change orders C = additional cost of work due to change orders P = actual payment to contractor by the owner P = actual payment to contractor by the owner F = contractor's gross profit F = contractor's gross profit R = basic percentage markup above the original estimate for fixeR = basic percentage markup above the original estimate for fixed fee contract d fee contract RiRi = premium percentage markup for contract type i such that the t= premium percentage markup for contract type i such that the total otal percentage markup is (R + percentage markup is (R + RiRi), e.g. (R + R1) for a lump sum contract, (R + R2) ), e.g. (R + R1) for a lump sum contract, (R + R2) for a unit price contract, and (R + R3) for a guaranteed maximumfor a unit price contract, and (R + R3) for a guaranteed maximum cost contract cost contract N = a factor in the target estimate for sharing the savings in cN = a factor in the target estimate for sharing the savings in cost as agreed upon ost as agreed upon by the owner and the contractor, with 0 N 1. by the owner and the contractor, with 0 N 1. Chris Hendrickson, 2000

Original Estimated Contract PricesOriginal Estimated Contract Prices

Adapted from Chris Hendrickson, 2000

Type of Contract Markup Contract Price

Lump sum M = (R +R1)EB = (1 + R + R1)E

Unit price M = (R + R2)EB = (1 + R + R2)E

Cost plus fixed % M = RA = RE B = (1 + R)ECost plus fixed fee M = RE B = (1 + R)E

Guaranteed max cost M = (R + R3)EB = (1 + R + R3)E

OwnerOwner’’s Actual Payment with s Actual Payment with Different Contract ProvisionsDifferent Contract Provisions

Type of Contract Change Order Payment Owner's PaymentLump sum C(1 + R + R1) P = B + C(1 + R + R1)Unit price C(1 + R + R2) P = (1 + R + R2)A + CCost plus fixed % C(1 + R) P = (1 + R)(A + C)Cost plus fixed fee C P = RE + A + CGuaranteed max cost 0 P = B

Adapted from Chris Hendrickson, 2000

ContractorContractor’’s Gross Profit with s Gross Profit with Different Contract ProvisionsDifferent Contract Provisions

Type of Contract Profit from Change Order Contractor's Gross ProfitLump sum C(R + R1) F = E - A + (R + R1)(E + C)Unit price C(R + R2 F = (R + R2)(A + C)Cost plus fixed % CR F = R (A + C)Cost plus fixed fee 0 F = REGuaranteed max cost -C F = (1 + R + R3)E - A - C

Adapted from Chris Hendrickson, 2000

Principles of Incentive Principles of Incentive ContractsContracts

TARGET COST: $20,000TARGET FEE: $1500SHARING RATIO: 80/20 %

•OWNER PAYS 80 % OF OVERRUN

•CONTRACTOR PAY 20 % OF OVERRUN

•PROFIT IS $1500 LESSCONTRACTOR’S 20 %

•OWNER KEEPS 80 % OF OVERRUN

•CONTRACTOR KEEPS 20 % OF OVERRUN

•PROFIT IS $1500 PLUSCONTRACTOR’S 20 %

Note: limitations may be imposed on price or profit

EXAMPLE

Additional profits are possible by lowering cost

Customer and contractor share cost savings

Kerzner, 2000

ConclusionConclusionWhen market is not very good, clients insists When market is not very good, clients insists on fixed price bids whereas when the project on fixed price bids whereas when the project offers are numerous, it is more difficult to offers are numerous, it is more difficult to obtain those conditionsobtain those conditionsThe contract type choice must depend on:The contract type choice must depend on:

The accuracy of the estimationThe accuracy of the estimationThe ultimate cost know since the beginning or at The ultimate cost know since the beginning or at least the maximumleast the maximumThe desired riskThe desired riskIf quick completion of work is wantedIf quick completion of work is wanted

Part IIIPart III

Award Methods Award Methods Contract SelectionContract Selection

Award Methods: Contractor Award Methods: Contractor SelectionSelection

ExtremesExtremes

Fixed Price

CommodityService

Reimbursable

Solicit based on Reputation and agree via Negotiation

Bidding

Product Type:

Payment method:

Award method

BiddingBidding

VariantsVariantsLow bidLow bidMultiMulti--parameter biddingparameter bidding

Low bid plus arithmetic combination of other factorsLow bid plus arithmetic combination of other factorsLow bid divided by ranking of other factorsLow bid divided by ranking of other factors

Fixed price low bid is winFixed price low bid is win--loseloseTypically associated with lumpTypically associated with lump--sum contractsum contractPrequalification criticalPrequalification critical

Bidding TradeoffsBidding TradeoffsTime provided to bidders to review documentsTime provided to bidders to review documents

Too long: Construction delayedToo long: Construction delayedToo short: Too short:

Bids lowBids low--quality because too little time to review contract quality because too little time to review contract docs (incorporate high risk premium or unrealistically docs (incorporate high risk premium or unrealistically low)low)Few bidders willing to participateFew bidders willing to participate

Bid countBid countToo many bidders: Scare away best contractorsToo many bidders: Scare away best contractorsToo few bidders: Bid not competitiveToo few bidders: Bid not competitive

Bidding TradeoffsBidding Tradeoffs

AdvantagesAdvantagesCan get good priceCan get good priceTransparencyTransparency

DisadvantagesDisadvantagesCan set up winCan set up win--lose situationlose situationCompetitive pressures can eliminate profit from bidCompetitive pressures can eliminate profit from bid

Try to make up with change orders, cutting cornersTry to make up with change orders, cutting cornersCan lead to combative relationshipsCan lead to combative relationships

Insufficient consideration of design before pricingInsufficient consideration of design before pricing

Bidding MetricsBidding Metrics

Most common: Price aloneMost common: Price aloneBidding Bidding ““capcap””: Bid on how far can go with set amount : Bid on how far can go with set amount of moneyof moneyMultiMulti--parameter bidding (increasingly popular)parameter bidding (increasingly popular)

Consider nonConsider non--price items (time, quality, qualification)price items (time, quality, qualification)A+B Additive measuresA+B Additive measures

Price+($/day)*days (common for retail), Price+($/day)*days (common for retail), Price+qualification+designPrice+qualification+designrank, rank, price+designprice+design rank,rank,……

A/B (e.g. B scoring along some metric: Design, etc.)A/B (e.g. B scoring along some metric: Design, etc.)

Issues with BidsIssues with Bids

Low bidders can be unreliableLow bidders can be unreliablePrequalify aggressively!Prequalify aggressively!

To allow for fastTo allow for fast--tracking may bid early (30%)tracking may bid early (30%)DonDon’’t try to force delivery from low bidt try to force delivery from low bidGrowing Frequency: innovative bidding methodGrowing Frequency: innovative bidding methodPressure for lowest bid can createPressure for lowest bid can create

Cutting cornersCutting cornersLowLow--quality personnelquality personnelBad feelingsBad feelings

Bidding ProcessBidding Process

A/E oversight typicalA/E oversight typicalPublicity (specifies qualification requirements)Publicity (specifies qualification requirements)Provide bid documentsProvide bid documents

Typically include fair cost estimate, sample contractTypically include fair cost estimate, sample contract

Answer Answer RFIsRFIsPrePre--bid conferencebid conference

Explain scope, working conditions, answer Explain scope, working conditions, answer questions, documented in writing)questions, documented in writing)

Public vs. Private BiddingPublic vs. Private Bidding

Public BiddingPublic BiddingMust be publicly advertised (posting in newspapers, Must be publicly advertised (posting in newspapers, public building, etc.)public building, etc.)Qualification occurs after submission of bidsQualification occurs after submission of bidsTypically 60 day period in which can submit bidsTypically 60 day period in which can submit bids

Private BiddingPrivate BiddingMay be by invitation onlyMay be by invitation onlyQualification occurs before submission of bidsQualification occurs before submission of bids

Dealing with WayDealing with Way--Out Low BidsOut Low Bids

Forcing collection from unrealistically low bids Forcing collection from unrealistically low bids is dangerousis dangerous

Construction highly contentious, poor moraleConstruction highly contentious, poor moraleRisk of extreme corner cuttingRisk of extreme corner cutting

Default is possible Default is possible DisruptionDisruptionInsurance companies fulfilling performance bonds very Insurance companies fulfilling performance bonds very difficult to work withdifficult to work with

Subcontracting BidsSubcontracting Bids

GCs push subs for lowest possible price before GCs push subs for lowest possible price before GC bidsGC bids

GC not obligated to use sub who gave bidGC not obligated to use sub who gave bidCan lead to serious predatory behaviorCan lead to serious predatory behavior

Bid shopping (before Bid shopping (before andand after GC wins bid)after GC wins bid)Bid peddling (unsolicited calls from subs to GCs Bid peddling (unsolicited calls from subs to GCs after GC wins bid)after GC wins bid)

Some owners/states require listing of chosen Some owners/states require listing of chosen subs at bid time or assign based on subsubs at bid time or assign based on sub--biddingbidding

QualificationsQualificationsCommon items for qualificationsCommon items for qualifications

Bonds/Insurance (bid, performance, payment)Bonds/Insurance (bid, performance, payment)Safety recordSafety recordReputationReputationFinancial strengthFinancial strengthTotal/Spare capacityTotal/Spare capacityLicensing Licensing Background in type of workBackground in type of workExperience in local area/labor marketExperience in local area/labor marketManagement system (QA, planning, estimation, control)Management system (QA, planning, estimation, control)Interest, adaptability shownInterest, adaptability shown

NegotiationNegotiation

Typically selected based on reputation, qualificationsTypically selected based on reputation, qualificationsTypically used for two casesTypically used for two cases

Very simple Very simple Use trusted, familiar partyUse trusted, familiar party

Very complex/bigVery complex/bigGet contractor involved in design, start work earlyGet contractor involved in design, start work early

Requires relatively savvy ownerRequires relatively savvy ownerEvaluate proposals, monitor performanceEvaluate proposals, monitor performance

Important even for DBB for postImportant even for DBB for post--bid changesbid changes

Negotiation ConsiderationsNegotiation Considerations

Can get winCan get win--win because of differences in win because of differences in Risk preferencesRisk preferencesRelative preferences for different attributesRelative preferences for different attributes

Goal is to find a Goal is to find a paretopareto optimal agreement optimal agreement Key skill in negotiation: Ability to find winKey skill in negotiation: Ability to find win--win win options options

Negotiation TipsNegotiation Tips

Try to maintain clear sense of reservation priceTry to maintain clear sense of reservation pricePrice or conditions under which will accept offerPrice or conditions under which will accept offer

Want to adopt some objective basis for positionWant to adopt some objective basis for positionWithout this impersonal criteria, other party can take Without this impersonal criteria, other party can take disagreements personally as arbitrarily demandsdisagreements personally as arbitrarily demands

Discuss multiple issues at onceDiscuss multiple issues at oncePermits trading off issues flexiblyPermits trading off issues flexibly

Formal exposure goodFormal exposure good––but experience gives but experience gives edgeedge

Negotiation Tips 2: Major Sins of Negotiation Tips 2: Major Sins of Negotiation (Thomson, 2001)Negotiation (Thomson, 2001)

Leaving money on the table: Failing to identify Leaving money on the table: Failing to identify and use winand use win--win opportunitieswin opportunitiesSettling for too little: Unnecessarily large Settling for too little: Unnecessarily large concessionsconcessionsWalking away from the table: Rejecting terms Walking away from the table: Rejecting terms that are favorable, often due to pridethat are favorable, often due to prideSettling for terms worse than existing alternative: Settling for terms worse than existing alternative: Pressure to reach some deal leads to opportunity Pressure to reach some deal leads to opportunity less attractive than opportunity costless attractive than opportunity cost